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With higher taxes on the horizon, investors are looking for any way they can to reduce their tax liability. There are many stocks, technically closed end funds or CEFs, which pay dividends that are tax free. This tax exempt income is generated from municipal bonds in the portfolio.

Municipal bonds are issued by states, counties, cities, and other governmental agencies. Income from these bonds is exempt from Federal income taxes, and if the bonds are issued in your state of residence, the income is exempt from state income taxes also. Municipal bonds issued by Puerto Rico and other U. S. dependencies are exempt from state income taxes for residents of most states. There are over 150 different tax free income stocks, according to the list which was recently updated at WallStreetNewsNetwork.com, with more than 25 of them yielding 7% or more, and in excess of 100 generating yields greater than 6%.

Issues to watch out for before investing:

Leverage
Beware of extremely high yield municipal bond CEFs which may use high leverage to attain their high yields. The higher the leverage, the higher the risk.

Management Fees
Watch out for are high management fees that can eat in to your earnings.

AMT
More and more citizens are being hit with the Alternative Minimum Tax, and many munis are subject to AMT.

Premium or Discount
CEFs are similar to bond mutual funds, in that they own a large portfolio of bonds. However, unlike mutual funds which are priced at the Net Asset Value at the end of the day, CEFs may trade at a premium or discount to Net Asset Value. Check to see if the closed end fund is selling at a premium or discount to its Net Asset Value (the intrinsic value of the CEF if all the bonds were sold off and the proceeds were distributed pro-rata to all shareholders). Obviously, you want to look for the ones trading at a discount.

Blackrock Apex Municipal Fund Inc. (APX), which yields 6.0%, is an example of a CEF trading at a slight discount, at 3.7% below NAV. It also utilizes almost no leverage at 3.9%, and has a decent below average management fee of 0.67%. It has been paying dividends since 1987.

Nuveen California Dividend Advantage Municipal Fund (NYSE:NAC) yields 6.6%, which is exempt from Federal and California state income taxes. It is trading at 3.5% discount to NAV. The leverage is 29.43%, which is below the average for all muni CEFs of 35%. Unfortunately, the management fee of 0.94% is higher than the average of 0.71%. The CEF has paid dividends since 1998.

Nuveen New York Performance Plus Municipal Fund (NYSE:NNP) sports a yield of 6.0%, exempt from Federal and New York State taxes, and trades at a 5.7% discount to NAV. The leverage is 27.82% and the management fee is 0.69%. Dividends have been paid since 1989.

Morgan Stanley Insured Municipal Income Trust (NYSE:IIM) also pays a 6.0% yield and trades at a 3.0% discount to NAV. Leverage of 35.41% is close to average, and the management fee of 0.53% is below average. The CEF has made payments since 1992.

The Putnam Managed Municipal Income Trust (NYSE:PMM) pays a fairly high yield of 7.2% and is selling at only 0.4% above NAV. The leverage is a low 26.65%, and the management fee is 0.75%. Dividends have been paid since 1989.

You can download an Excel database spreadsheet list of over 150 tax free stocks at WSNN.com. The database contains extensive information including the company, the symbol, the yield, the net asset value, recent price, premium or discount, the leverage, the management fee, when the CEF was founded, the fund's focus (state or national), percent subject to Alternative Minimum Tax, and other information. Keep in mind that both yields and share prices fluctuate, and there is always the possibility of bonds in the portfolios defaulting.

Disclosure: Author does not own any of the above.

Source: Five Closed-End Funds That Pay Tax Free Dividends